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Friday, February 4, 2011

Is Debt Settlement for you?

You may be drowning in a river of debt at this time. It seems that there is no end in sight to the amount of calls that you receive from creditors and debt collection agencies. Your family members may get embarrassing calls from creditors about your bills! You have some sleepless nights on account of worrying about how your bills will be paid and your plummeting credit score. You see the commercials on television, for debt consolidation or debt settlement. The commercial urges you to “get your bail out now!, so you quickly jot down the company’s 1-800 phone number. The debt relief company in the ad looks very professional and you think the debt relief company has the answer to all your problems. You leap off your couch in a frenzy, grab the phone and start dialing those digits. Hey! Not so fast, Speedy! There are some things that you ought to think about before you make a decision .

How does Debt Settlement work?

A reputable debt relief company that offers this type of service will typically analyze each client’s financial situation on a case by case basis. The client will have to bare all, when it comes to how much debt he or she is really in versus monthly income. If the client qualifies for the service, the debt relief company will recommend that the client stop paying the creditors (if the client hasn’t already). The money that the client would have paid to creditors, would then be deposited into an escrow account until enough money is saved up to make either a lump sum payment or installment payments to creditors. The debt relief company would also contact the creditors and negotiate with them for lower interest payments and/or to reduce the amount on the outstanding debt. In many cases, the debt relief company may be able to eliminate 50% or more of the debt.

The Downside of Debt Settlement

As with many things, there are pro and cons. When people agree to these services, they are not getting them for free. I am not averse to companies making a profit. However, a prospective client can expect to pay 10% -30% of the amount of debt that is wiped away by the debt relief company. For example, a client has a total of $50,000 in credit card debt. The debt relief company negotiates a settlement with the client’s creditors for $25,000. Half of the debt is gone, but the debt relief company charges 30% of the amount that was reduced. Therefore, the client ends up paying $7,500 in service fees to the debt relief company.

Please be aware that under the FTC’s new regulations, for profit debt relief companies are no longer allowed to charge up front fees for their services. The debt relief company must demonstrate that work is actually being done on the client’s behalf before any fees are charged. Non-profit debt relief companies are allowed to charge up front fees, which tend to be very reasonable (about $75 or less).

Debt settlement will almost certainly hurt your credit score. When current creditors and prospective creditors see settled debt on your credit report, may be rated as a credit risk. The debt relief company must disclose how debt settlement will affect your credit score.

The debt relief company should also explain what the tax ramifications are for settling debt. It is possible that you will be on the hook for the difference between what the original debt amount and the final settled amount is. For example, the debt settlement company saves you $15,000, off an original debt of $30,000. You might be responsible for taxes on the $15,000 saved.

Just because a debtor is working with a debt relief company, doesn’t mean that the creditor won’t turn around and sue the debtor. Creditors that can’t communicate with debtors, may get upset when the debtors stop communications and payments. The creditors may decide to take legal action up to and including lawsuits and garnishments. If a debt relief company doesn’t disclose this to you when you are deciding whether to use their services, then it’s a bad sign.

Debt settlement services are useful for someone who does not like to research, make phone calls, or negotiate with creditors. It puts the consumer at a disadvantage though, since it takes away decision making power. Almost everything is left in the hands of the debt relief company, which is potentially dangerous. The consumer should always be knowledgeable about any business undertaking to avoid getting the short end of the stick.

Alternatives

Do the legwork and negotiating with creditors on your own. If you aren’t paying your debts, the creditors may be willing to work with you to get something out of you, rather than nothing. If you do go this route, request in writing that your creditor reports that the debt is “paid in full” instead of “settled” on your credit report. A credit report of “paid in full” looks much better on your credit score than, “settled”. Just make sure that all of the terms are agreed to in writing. Getting things in writing will also protect you from future legal action by creditors. There are also do-it-yourself debt settlement companies out there that can assist you. Doing the legwork yourself, will save you lots of money if done properly.

You can also try enlisting the help of Consumer Credit Counseling Services. A certified counselor will assess your situation to see if you qualify for a debt management program. Most of the time, consumers still end up paying the principal balance of outstanding debt. CCCS usually negotiates lower interest rates for the consumers, and help to set up a repayment plan. You can find a Certified Consumer Credit Counselor through the National Foundation for Credit Counseling by going to www.nfcc.org.

Bankruptcy may be another option if you owe more money to creditors than you possess in assets, with very little ability to repay creditors (insolvency). Bankruptcy proceedings fall under the jurisdiction of the federal court system. The types of bankruptcy available for individuals are chapter 7 and chapter 13. Once a bankruptcy is filed, all lawsuits, garnishments and contacts from creditors are put on hold. Keep in mind that your credit rating will be ruined for 7- 10 years after bankruptcy. Also, bankruptcy does not necessarily wipe away all debts, such as taxes, student loans, or debt incurred through fraud and criminal restitution. Bankruptcy may be the only option available for many people, and the best way to find out if it is for you is to consult a licensed, experienced bankruptcy attorney in your state.

In closing, the services offered by debt relief companies may beneficial, if the customer is dealing with a trusted and reputable company. It is really up to the consumer to roll up those sleeves and do the necessary work that it takes to educate oneself on what he or she is getting into. There are honest debt relief companies out there but the consumer needs to discover them or get recommendations from satisfied customers. The smart consumer would check the reputation of the company with the Better Business Bureau, the state attorney general’s office, and the FTC to see if any complaints or lawsuits are filed against the debt relief company. A bad financial situation could go to worse if, the consumer does business with an unethical debt relief company.